No matter which retirement system you are covered under, deciding how to protect your spouse is an important and sometimes very complicated decision. Remember that if you live a long time in retirement, inflation can become a major factor. Ask each other one big question: “If I die first, how will that leave you financially?” Or, conversely, “If you die first, how will that leave me financially?”
Jittery investors who are fearful about outliving their savings may have another investment option to consider in their workplace retirement plans. The Treasury Department has issued new guidelines designed to expand the use of annuities inside 401(k) plans.
Annuities are attractive to some investors because they offer the ability to build tax-deferred savings, can help to protect the money that you’ve already saved, and generate a steady stream of income in retirement.
From wealth accumulation strategies to withdrawal strategies, the financial world is built upon the foundation of an ever-rising stock market that can return high-single-digit to low-double-digit compounded gains over a person’s investing lifetime.
However, Stocks have declined by 40% or more twice in the past 15 years. With the volatility in the market today, you can’t time a bottom or anything else perfectly—what stocks might do next quarter, or when the next crash might come—can be complicating - even though the U.S. stocks climbed on Friday, with Wall Street derailing a four-week slide with its best week this year.
The problem with trying to take advantage of current opportunities is that we have no idea how appealing future opportunities might become. There is a long history of pundits calling a bottom, followed by months or years of things getting worse. The recent retreat from all-time highs for the Dow Jones Industrial Average (DIA), S&P 500 (SPY), and Russell 2000 (IWM), likely caused more than a few investors have stomach aches.
Recently, the S&P 500 fell 9.8% in price from its September high through Oct. 15. That hardly is a crash, and markets have since rebounded, but it was enough to put fear back into the picture and tempt more bad behavior. As the great investor Benjamin Graham said, “Everyone on Wall Street is so smart that their brilliance offsets each other.”
Right now, all signs point to investors doing nothing. If the market’s decline is over, that’s the right move, but there is plenty of disagreement as to whether the worst is over, or just beginning. The market’s flip-flop was nothing to panic over, but many stop short of calling it a buying opportunity, noting that as a value-oriented investor they don’t believe stocks have reached bargain levels.
The worries of last week are certainly in the rear-view mirror. Two weeks ago everyone was panicking, and this week everyone thinks everything is fine. You typically can’t see complacency without looking in the rear-view mirror. So when investors get closer to year’s end and look back on the last few weeks of market action, the question is what they will see in hindsight.
Sometimes, the best advice is “Don’t just do something, stand there.”It’s okay to be a deer in the headlights, “so long as you’re not standing in the road.”
When an investor invests in an idea, he will tend to ignore or play down the importance of information which might suggest that he is wrong. Almost all investors need their money to work for them for a long period, so focusing on short-term predictions actually decreases their chance of achieving their long-term goals. The real bubble is not in the stock market, but in stock market apathy.
In the last five years, the percentage of your household’s financial assets invested in the securities markets has increased by a whopping 25%. That’s a major behavioral change from what you had doing been since the last recession: shunning the markets, hoarding cash—even in retirement accounts—stockpiling treasury bonds and gold, deleveraging your personal balance sheet, and waiting for the next shoe to drop. But that was then…
There are no stock market heroes, no mutual fund kings, and zero new investing celebrities. As of this writing, you (the collective “you,” that is) hold some $13.3 trillion in corporate equities, defined as stocks and bonds issued by corporations. Approximately $7.7 trillion of this total is in mutual funds. This means that approximately 35% of all household financial assets are “at risk.”
Investors who were nervous as the market went through its short decline have gotten most of that downturn back, and may now want to protect some of their winnings. In any case, investors should be advised that reaching for yield can be highly speculative and these strategies are on the higher risk end of the investment spectrum.
Nevertheless, we believe that, on a risk-adjusted basis, Fixed Indexed Annuities might be a better way of reaching for yield in the current environment for those who cannot accept the risks involved. When stock markets tumbled around the world last week, annuities remained solid once again. It’s a reminder of the value of annuities in a diversified portfolio.
As many people enter retirement, their investment focus shifts to stability and income. And, for better or worse, guaranteed income products like bonds or annuities are still the asset classes people think of first when it comes to stability and income.
In the near future most equities will be owned by retirees or those close to retirement, and that creates several problems for the stock market. The term “decumulation phase” whereas retirees start drawing down their 401(k)s that could strain the financial markets.
Additionally, baby-boomers are unlikely to be willing to stomach the 30% to 50% decline in equities that is likely to occur at least once during their retirement (when a bear market pops up). The need for capital preservation will be enough to push money into “lower volatility outcomes” creating additional selling pressure on equities.
Worried about outliving your money? You share that fear with many baby boomers. No one wants to spend their last dollar before the last day of their life. Because you can’t tell when that day will be – and because you may need more income long before that day arrives – you may want to look into an immediate annuity.
An immediate annuity provides “immediate” income. In fact, immediate annuities are income contracts issued by insurance companies. They have been around for decades, and actually trace their roots back to the Roman Empire.
One example of a Single Premium Immediate Annuity (SPIA) can be a Fixed Index Annuity (FIA).
Establishing an SPIA is a pretty straightforward matter. An individual pays a single premium (lump sum) to an insurer. The lump sum becomes the principal of the annuity. The insurer invests the money, and it earns interest that reflects the performance of an index fund, usually the S&P 500. (Even if the linked index performs poorly, there is usually a minimum guaranteed return for the annuity.)
The insurance firm subsequently makes monthly payments to the annuity holder, payments that it guarantees will last a lifetime.
• How much income are we talking about?: Broadly speaking, if you’re in your 50s or 60s and put $100,000 in an immediate annuity today, you could receive monthly payments in the $450-$550 range, or around $5,500-$6,750 a year for the rest of your life. The payments are a combination of principal, interest and what insurers term a “mortality credit” that increases with time. Essentially, you get “bonus points” for living longer. As you age, the payments grow incrementally larger.
• You also have payment options: Some SPIAs feature joint payouts (they pay a couple instead of an individual). Some are termed life with cash refund (whatever is left of the principal when you die goes to a beneficiary in a lump sum), others life with installment refund (the same, except the remaining principal goes to a beneficiary in installments).
Some offer a period certain only option (the payments to the annuity holder are arranged to go on for X number of years and then cease). Some are life with death benefit (with a certain percentage of the principal dedicated to the death benefit for your heirs). If you have absolutely no heirs, there is even a life only payment option, whereby you get the highest possible annuity payments but the insurer gets to keep 100 percent of any remaining principal if you die.
• Immediate annuities differ from deferred annuities in a key respect: There are two phases to a deferred annuity: the accumulation phase and the income phase. Assets grow during the accumulation phase. Years later, the income phase begins and payments are made to the annuity holder out of the accumulated principal. If you opt for a deferred annuity, you may have to wait 5-10 years for that first income payment to arrive. With immediate annuities, the income stream starts immediately (or if you prefer, within a year).
• Immediate annuities can provide a potential tax advantage: Many deferred annuities are held within traditional IRAs (Individual Retirement Account), and therefore the earnings and investment results grow tax-deferred during the deferral phase. But when the income phase starts and the tax-deferred earnings are paid out, the IRS wants a fair share. Immediate annuities can also be used in IRAs that require minimum distributions beginning at age 70½.
Outside of a qualified plan an immediate annuity pays back both principal and tax-deferred interest to the annuity holder, a portion of each payment is considered to be income in the eyes of the IRS, and a portion is considered to be tax-free return of principal. The shorter the payout period the greater the amount that can be excluded from tax.
Traditional IRA withdrawals are calculated to encourage the distribution of IRA balances over a person’s lifetime. With longer lifespans, the tables the IRS uses for this calculation risk fast becoming obsolete – and that raises the very real threat of outliving your IRA assets. However, if those assets are invested in an immediate annuity, a lifetime income stream can be assured and as noted above, the IRS will accept that income stream amount as an acceptable required minimum distribution (RMD).
• So, does it make sense to annuitize?: If you’re healthy, active and mature, an immediate annuity can potentially be a great income source for you. But before you arrange an annuity contract, talk to a financial advisor or insurance agent who understands these investments thoroughly, one who can explain your options.
Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10 percent IRS penalty tax and surrender charges may apply.
Final Note: IRS: In issuing its special ruling on Deferred annuities in 401(k)s – and is expected to boost the popularity of lifetime-income options, helping employees hedge against the potential of running out of money in retirement.
Along those lines, the IRS in July issued final rules allowing defined contribution participants to invest a maximum of $125,000 in qualifying longevity annuity contracts that guarantee income later in retirement. Assets in those longevity annuities are not subject to the annual distribution requirements of 401(k) assets that begin at age 70 ½, according to the IRS.
The Treasury Department’s new guidance for annuities in 401(k) plans could help investors allocate their money more effectively. “To the average employee, choosing suitable investments might as well be learning rocket science. As a result, many either do not choose any investments or make blind and uneducated choices. With these annuities as investment options, making suitable choices can be easier.”
Today’s guidance provides plan sponsors an additional option to make it easier for employees to consider using lifetime income as.employees can now use a portion of their savings to purchase guaranteed income for life while retaining other savings in other investments.”
Americans are less prepared for retirement since the decline of defined benefit plans in favor of defined contribution plans. The main concern across the nation is the financial worry of having the ability to retire comfortably. We are living longer, but the life expectancy of our money may have trouble keeping pace.
We have some big assumptions that go into any retirement projection. For instance, inflation rates for decades. Over 20 years, even a 3.5 percent inflation rate will cause prices to double. So expect that today’s $2 loaf of bread will cost $4 in 20 years.
The combination of longer retirements and more exaggerated cycles in financial markets heightens what is called longevity risk, the possibility of running out of money before running out of time. If income is not ample, a retiree may be forced to either continue working, or face a more modest retirement lifestyle.
An affirmative answer comes down to two things: investing intelligently and allocating assets correctly. If you don’t, you may witness a train wreck in slow motion, degrading your future quality of life. As Harry S. Truman explained, ‘It’s a recession when your neighbor loses his job; it’s a depression when you lose your own.
Social Security retirement benefits normally may be taken as early as age 62, but your income will be substantially higher if you can afford to wait. There’s tremendous value to deferring until 70. Social Security is the best-priced annuity you’re going to buy.
Many suggest that you need to withdraw your retirement funds slowly – The other way you get paid in retirement is to invest your money for growth and income in a way that makes sense based on your risk tolerance – then come up with a plan for how to withdraw your money.
Many people focus on the 4 percent rule which essentially says that as long as you withdraw no more than 4 percent from your retirement accounts each year, the money should last you 30 years. Unfortunately, as we’ve learned recently, if the markets tumble big during your first few years of retirement this rule is going to fail you.
Indeed, you need to be very conservative about how much you’re withdrawing in the early years of retirement, especially if the market isn’t performing well. The fact that so many people tell us they’re planning on working in retirement means they don’t trust that they will actually get the investment returns they need but working longer may be a good thing – the income can subsidize a lower level of withdrawals.
One investment vehicle, an income annuity — which in exchange for an initial lump sum typically pays a fixed monthly amount, no matter how long the holder lives — is good to counter longevity risk. There is a way to make sure your money lasts after you leave the work force.
Convert savings into an immediate or longevity annuity – Take a lump sum of money and use it to buy yourself a paycheck. Depending on the circumstances, this paycheck can last the rest of your life and your spouse’s life.
A sliver of silver lining is the fact that Annuities are a powerful tool for managing cash flow. Guaranteed lifetime income products make it easier to manage a budget and provide more long-term security than other financial product.
The sooner an investor puts up the lump sum, the cheaper a certain fixed payment later will be. A deferred income annuity is similar to an immediate income annuity, however guaranteed income payments typically start anywhere between 5 to 20 years after purchase.
A 55-year-old man buying an annuity would need to put down only $50,000 to collect $625 each month starting at 70, while a 70-year-old man would need $100,000 to buy immediate monthly payments of the same amount.
It may be possible for the 55-year-old to come out ahead by keeping his $50,000 for 15 years, investing it and buying an annuity at 70. But the point of an annuity is to produce guaranteed income, so for someone who wants that, why not guarantee the amount sooner?
You have to remember that even at 65 you still have a couple of decades to live on average and a decent shot at significantly more than that. That means you can’t put all of your money in safe havens. You still need at least some growth from stocks. But how much should you keep in? Take 100 and subtract your age. That’s about the percentage of your portfolio you should keep in stocks.
Being able to rely on annuity income allows working and retired people to take more risks with their other assets, say, by owning more stocks to try to capture growth and not just income. That used to be discouraged for retirees in case the market plunged just when they needed their money.
With an “immediate annuity” you take a sum of money at retirement and buy a paycheck. The amount you’ll get for your money depends on your age/life expectancy and interest rates. The older you are when you buy an annuity, the shorter your life expectancy will be – so the greater a monthly paycheck the same sum of money will buy you.
When interest rates are higher, the size of the paycheck for the same sum of money will rise also. For that reason, it makes sense to not annuitize all at once, but to annuitize chunks of money over time as your fixed expenses rise.
A longevity annuity works the same way: you buy it at say age 50 but don’t start drawing your paycheck until retirement. Because the money has that 15 years (or however many) to grow, your paycheck is much larger.
We’re living longer, better and healthier, and we’re going to continue to be more active. It’s not about how long you live, but how well you live long
The recent volatility in the financial markets have left many Americans feeling jittery. The Dow and S&P indexes suffered some of their worst losses of the year last week, and a shocking price move in the bond market sent the benchmark 10-year Treasury yield below 2 percent, the lowest level in over a year.
The market that needed a shot in the arm, instead got a shot in the foot. The uncertainty has played a starring role in the return of the ‘fear trade ’While the first stage of this selloff could be viewed as a “healthy adjustment” over excessive valuations in some markets such as the U.S., in the later stages fear has been a major driver for that stock slide.
Stocks remain, on the face of it, far more attractive than other asset classes such as bonds, but relative value does not equate to absolute value. The market today seems like you have square pegs in round holes, but as the economy tightens, Wall Street is working hard to soothe market participants much like a parent comforting a child waking from a nightmare (never mind that the odds of such an action seem quite long).
Trees don’t grow to the sky and neither do stocks. At the very least, investors should avail themselves of the low cost of insurance, often recommended to protect the gains that they have enjoyed during this epic five-year bull market run.
Providing a steady income is often the key problem involved in retirement planning. Longer life spans raise the issue of the impact of inflation on fixed dollar payments, as well as the possibility of outliving retirement funds.
Even with Social Security retirement benefits and income from employer-sponsored retirement, the cold hard realities of retirement still exist. Outliving your money and poor health are still challenges that retirees must consider. With people living longer, life expectancy has created the biggest change in retirement planning.
For years retirees looked for principal protection and market participation, so they benefited from a strategy that invests a portion of their assets in a conservative investments, such as bonds, and the remaining portion of your assets in the stock market, for upside potential.
Many investors in the past few years have discovered a different strategy for a portion of their bond portfolio that retains the fixed income nature of bonds while offering protection from bond and equity market declines. It’s called fixed-index annuities, or “FIAs.”
A fixed index annuity combines the security of a guaranteed interest rate with the potential to earn additional interest linked to the return of an index. Fixed Indexed Annuities are “consumer-friendly products” that make sense to a lot of people as a certificate-of-deposit or a bond alternative.
For retirees seeking steady retirement income—typically drawn to products such as certificates of deposit and safe-haven bonds—these annuities can make sense. Fixed annuities are a type of savings contract with a tax-deferred interest component. “Indexed” versions link the annual interest to a stock-market benchmark, most commonly the S&P 500. Insurers promise to protect buyers against market losses but cap the upside gain they pay.
An indexed annuity is a contract issued and guaranteed by an insurance company. You invest an amount of money (premium) in return for protection against down markets, and the potential for some investment growth, which is linked to an index (e.g., the S&P 500®), and in some cases a guaranteed level of lifetime income through optional riders.
Some replacement investments have included dividend stocks. While this has provided an alternative source of income, i.e., dividends, it has also resulted in increased equity risk exposure, which may prove to be more problematic than simply remaining in bonds.
FIA’s offer several distinct advantages over bonds, including protection from market declines, elimination of bond default risk, participation in positive performance of stock market indexes, tax deferral in non-retirement accounts, sustainable lifetime income with a MGWB or income rider, investment management simplification, and elimination of investment management fees on the portion of a managed portfolio that’s invested in FIA’s.
First of all, let me explain the details of an indexed annuity (also called an equity-indexed annuity, fixed-index annuity, hybrid annuity). An indexed annuity is a fixed annuity with a call option on an index, usually the Standard & Poor’s 500 Index. The vast majority of the call options are one year in length, but can be as long as five years.
The S&P 500 index represents over 90% of the index option choices even though other index selections (Dow, Nasdaq, etc.) can be found in some product offerings. These call options allow you limited participation in the upside of the index (not including dividends).
Because your potential gains are attached to a call option, if the markets go down and the call option expires worthless at your contract anniversary date, then you will not lose any money. If you have gains from your index option, that gain is locked in permanently, never to go below that amount.
Indexing strategies provide the opportunity to earn interest based on the performance of a defined stock market index each contract year, with the Standard & Poor’s 500 Index being the most prevalent offering. Unlike a direct investment in an index where you participate in gains as well as losses, there are two basic differences when you allocate funds to an indexing strategy within an FIA:
1. If the index’s return is negative, no loss is posted to your account.
2. If the index’s return is positive, interest is credited to your account subject to a cap.
In other words, unlike bond and equity investments, you won’t participate in losses, however, you also won’t fully participate in gains to the extent that the performance of a particular indexing strategy exceeds that of a defined cap.
To provide flexibility matching the purchasers risk profile there are different call options – like “spread”, “cap”, “point to point”, “monthly sum”, Do the math calculations to see which option choices work best for you. . With the majority of index annuities, your gains are locked in at the contract anniversary date.
FIAs do come with a limited upside - For example, if the cap on the upside is 7% and the S&P 500 returns 12% during your one-year option, then you will receive 7%. Indexed annuity options returns do not include dividends. The upside to an indexed annuity is that there is no downside. The downside to an indexed annuity is that there is limited upside.
FIAs provide the possibility to capture market dips with the “Reset” provision- As an example, if the S&P 500 index goes from 1,800 to 1300 in one year, your index option for that year would not credit any gains, but you would start the next index option year at 1300 on the S&P 500.
An FIA can provide the policyholder with the financial support they need to pay for unexpected health expenses. FIAs offer solutions to these problems by offering riders to policies that either are or may be added to an annuity to protect policyholders’ future long term and immediate health costs needs.
These riders can provide additional financial flexibility as unforeseen health costs confront the insured. This includes certain amendments that expand the purchased policy’s benefits. Today’s fixed indexed annuities offer a range of benefits designed to protect your retirement savings from market loss, give you income for life and allow you to pass along money to your heirs.
An FIA allows you to set aside a principal amount that will remain protected in the event of a market downturn, with capped interest growth if the market rises. An FIA will protect your nest egg and give income options providing a retirement income you can depend on for life. Most indexed annuities, when used for lifetime income purposes with attached income riders, have a higher actuarial percentage payout for income.
As retirement approaches, the investor contemplates how to eventually convert savings into an income stream without the benefit of continuous earnings from a full time job. There is a good chance that interest and dividend income will not be sufficient to support cash flow needs in retirement and that a withdrawal strategy that includes a reduction in principal will be required.
To that end, an additional set of risks such as inflation risk, longevity risk and sequence-of-returns risk appear on the horizon for the investor and threaten the chances of financial success in retirement.
Overall, consumers ages 55 to 75 see great value in having guaranteed lifetime income in addition to Social Security. Most retirees say they receive far more income from guaranteed income sources than from non-guaranteed sources. According to consumers, the two leading benefits that guaranteed lifetime income products provide are peace of mind and making it easier to know how much to spend.
Building up enough retirement income to live comfortably until the end of your days isn’t as difficult as it might seem, so long as you start saving and investing early and understand that the process evolves throughout your lifetime. Continuing to throw your hat in the ring over the long term will give your portfolio a chance to outperform and last throughout your lifetime.
Families will have a greater degree of financial security by making retirement decisions earlier rather than later. But it’s never too late to plan for the future even for those retirees with a solid nest egg and keen planning. The increasing lifespan and the likelihood of needing significant physical assistance and even long-term-care placement for many years prior to death may significantly undermine financial projections.
The key is to start saving/investing early in life and be consistent (save with every paycheck). The power of compounding is lost on many people. Also maxing out contributions when possible, eliminating debt, avoiding risks with your nest egg, planning for multiple streams of income once retired (pensions, dividends, part time work, etc.) should all be part of everyone’s plan.
Financial experts’ rule of thumb is that retirees need 70 percent of the income that they earned during their working years. If there’s a gap between your savings and the amount you think you’ll need in retirement, you can either work longer, scale back on your retirement plans, consider a part-time job to help cover the shortfall, or buying an annuity can help create the steady and guaranteed income that can give retirees peace of mind.
By purchasing an annuity that, combined with Social Security and possibly a pension, will cover just the fixed costs they’ll face in retirement. That way, they have the confidence of knowing that we don’t have to draw from investments to cover those costs, and regardless of what happens, those costs are covered
Retirement planners have touted the “4 percent rule” for years. Under it, they say retirees can safely withdraw 4 percent of their total assets in their first year of retirement, and withdraw that amount, adjusted for inflation, thereafter. The problem with that, as many new retirees learned in 2008, is that if the market crashes early on in your retirement, your assets could suffer irreparable damage.
The fix, is having a cash cushion to see you through the next market crunch. It is recommended that retirees keep at least two to three years’ worth of expenses in an emergency account, so they can avoid pulling money out of the market when it’s falling. Or have a guaranteed income account.
What happens when one spouse unexpectedly predeceases the other? Planning for such a contingency need not be overwhelming, but it is vital to fold this concept into your retirement planning as early as possible. The choices you and your spouse make before retiring can make the difference between a surviving spouse living comfortably or one being left with little financial support.
It’s important to think about this issue early on, because once you make a decision regarding the administration of your pension, it’s permanent. If your spouse will need your pension in the event that you die first, then crunch some numbers to decide which option will work best for you.
Guaranteed lifetime income products make it easier to manage a budget and provide more long-term security than other financial product. A deferred income annuity is similar to an immediate income annuity, however guaranteed income payments typically start anywhere between 5 to 20 years after purchase.
The longer the time between purchase and the start of income, the higher the amount of guaranteed lifetime payment. Many deferred income annuities guarantee payments for 10 years even if you do not live that long. Like any insurance, the benefits received from an annuity contract can be tied to either the lifetime of one person (a Single Life contract) or two people (a Joint Life contract).
An annuity is an insurance contract that provides protection in the event of someone living too long (in the form of a sustainable income stream), whereas a life insurance policy provides protection in the event of someone dying too soon (in the form of a lump sum payment to the estate). Both forms of insurance are based on a mortality table (i.e., a “probability of death” table) managed by actuaries at the insurance carrier.
Deferred income annuities typically make the highest monthly income payments among sources of retirement income and there are no additional costs or fees associated, but you cannot withdraw the cash value of the account beyond these monthly payments. For example, if you deposited $100,000 into a contract at age 55 and waited until age 65 to receive payments, you can expect to receive approximately $9,300 per year for the rest of your life.
Income Annuities are used in situations where the investor needs to create – and specifically define – a source of guaranteed and predictable income. There are no explicit fees associated with an Income Annuity. Like a Bank CD, these expenses are embedded in the rate you are given.
When withdrawals are made from a retirement savings account, the investment performance or return of the account can be negatively impacted in a significant way, especially during a down market. On the other hand, if withdrawals take place during an up market, the account is not as severely impacted.
The timing of market returns is important and is an additional risk that needs to be addressed. As an individual, one does not get to choose retirement based on what market sequence will materialize. Sequence-of-Returns risk may force the individual to adjust his/her standard of living in retirement and, in extreme cases, can cause a dependency on social programs, friends, and family.
By allocating retirement savings across investment and insurance-based products in proper proportions, one can effectively combat the additional risks found in retirement (inflation risk, longevity risk, and sequence of returns risk).
The impact of longevity and the risk of outliving one’s investments are real. Rather than trying to predict the future for inflation, longevity, and sequence-of-returns in the market, an investor should consider insuring against potentially adverse outcomes by adopting a product allocation strategy that aligns different types of annuities combined with investment accounts that can balance and fine-tune the sustainability and legacy trade-off throughout retirement.